ESOP Benefit Distributions

well welcome again this webinar is brought to you by the ohio employee ownership center an employee ownership training and outreach organization located at Kent State University in Kent Ohio today we have Pete Schuler of Crowe Horwath in Columbus Ohio and our session is entitled ESOP benefit distributions a critical administrative issue take it away ok thanks everybody for attending this webinar today I think this is a great way to get good information across and thanks to you Jay and the OEO C for inviting me to do this my name is jay said is peach Schuler I'm a partner with Crowe Horwath a lot of you I know and know me I recognize a lot of familiar names out there but we we administer employee stock ownership plans mr. about 500 of them and so we see a lot of different distribution issues a lot of different ways of handling distributions and we're going to talk about all that today it is by the way the one area of Aesop's where we get the most questions after the ESOP has already been put into place so it's a very hot topic and we will go ahead and get started first I just kind of goes through what we're going to talk about and the focus of this talk although we'll touch on many things is kind of what I would call the mechanics of distributions in other words how do you actually do them so we do get into the legal stuff we get into what your plan can't have and can't have but we also are focusing on how do you actually pay distributions so I will just go ahead and get started so who gets a distribution first of all and this can can vary widely and does vary widely amongst Aesop's the plan document and the distribution policy provisions governed who is going to receive a distribution the plan document will often be written very broadly and I'll get to what I mean by broadly in a minute and then the distribution policy generally flushes that out and says okay we may pay a person out after five years or we may wait five years but we don't want to wait five years we want to pay them out after a year so the distribution policy would say we're going to pay them out after the year and after they terminated so the distribution policy is something you should have in writing I know that some companies don't they just know how they're paying distributions it should be in writing if you undergo an audit IRS DOL loves to see that in writing and also if the people with that knowledge in their head leave the firm for whatever reason you know you no longer have that knowledge so what is the what what are the maximum that you can do on distributions well there's what we call the big three in the ESOP world death disability retirement which you'll see referred to here in the presentation at a DDR and a person must be offered a distribution after the plan year end in which that event occurs so in which they retire we say decease or which have become disabled they must be offered a distribution after that plan you're asked for any other termination you can wait up to the fifth planet plain year following the plain year in which that occurs so for example on that other one kind of hard to think through the way the text reads but if someone were to terminate this year in 2012 they would need to be offered a distribution after the twelve 3117 allocation is completed and thus be paid out by twelve 3118 assuming a calendar year end and so that's all that that confusing language means and those are the the broadest that you can go a lot of plain documents as I said we'll have those will say we may wait up to five years etc however like I said you then flush that out with what's the way that you actually want to pay out distributions if you are leveraged these up you may have this language in your ESOP and this allows for the portion of a participants account that was purchased with an esop loan for the distribution related to that portion in that portion only to be delayed until the ESOP loan is paid this will often be there's some controversy or not not controversy won't say that there's some disagreement because of the way the code is written as to whether this can apply to s corpse as well as C corpse and so that's really an issue that when the plane is being drafted would have been discussed with your attorney but but what it allows is for while you're repaying that loan you also don't have to also pay distributions of stock purchase with that loan now for a particular participant has other stock in his or her account or has cash in his or her account those are not subject to the delay just to stock purchased with that loan often we will see this language but then a plan can carve out certain exceptions so once again DDR death disability retirement may be carved out they don't have to be carved out but they may be an see may it may say we're delaying for everybody except DDR also sometimes will see a small balance exception so anybody under $1,000 or under $5,000 we're going to pay their entire account balance out including these leverage shares but everybody else we're going to delay and generally what happens is this is put into an esop just to manage cash flow in the initial years of an esop what we tend to see is that this kind of goes away as the company pays down really the external debt because that's what's actually driving cash flow issues as it pays that down as cash flow becomes less of an issue we tend to see this taken out of the plan also there is one situation that you can't delay and that is if a participant is age 65 has at least 10 years of participation in the ESOP and has terminated those three things that's an overall ERISA rule that you have to offer a participant a distribution of their entire account balance at that point in time and as Jay said ask ask questions as we go here if you have any and we'll get them taken care of other other than that I'll just keep rolling forward so how much does a participant get well one of the things of course is their account balance which I'll talk about in a second but the other thing is their vested account balance so they have an account balance but but what how much of it really belongs to them that's based on their years of service and specifically theirs theirs will be a chart in the plan document that relates years of service to a percentage of vesting many Aesop's now would use a 6-year graded where a participant is 0% vested for the first 4 0 & 1 years of service so then when they earn 2 years of service they get 20% and they add 20% for each additional year of service that they earned and a year of service is a plain year in which they work at least a thousand hours typically there can be variations on that but that is typically what a year how your service is defined so what we would look at is their account balance we would look at how many years of service they have and and that helps us determine what percentage of their account balance they would receive once again there there are often I would say more so than not several events that cause immediate vesting and that's death disability retirement they don't have to but most plans do that so a person will become under percent vested at death disability retirement sometimes also early retirement if there's early early retirement provision in the plan very important to you know provide your TPA with accurate records so they can track the vesting appropriately and also if you're paying distributions out in the same year of termination which is not common in the ESOP world but it does occur you need to make sure you're updating vesting for that particular year so for example if a person were to leave in July of 2012 and your plane allows for them to receive a distribution right away they've probably if they're a regular full-time worker worked a thousand hours and so you would want to make sure to get the updated vesting from your TPA because they've another year of vesting service and then so how much do they get so we have the vesting percentage we know how to apply that you're using your all when a person is being paid at distribution you're always going to use their most current account balance and account value there's often the misunderstanding that somehow a participants the value of their stock account is locked in at the time they separate from employment so that let's say they don't take a distribution for five years after that they're still receiving their stock at that old value and that's not the case whatever is in their account they receive the current value and I often liken it to 401k plan when a person takes a distribution from a 401k plan there's a value attached to those to their mutual funds in the 401k plan and and that value has been updated to the most recent period usually the most recent day and and then they're paid out that amount so it's very similar if they have stock in their account it continues to go up and down even though they were terminated participant and that's the value right the most recent valuation before they take a distribution is what they receive so it's a plan your end valuation before they take a payout that's here to consult the plan document to determine the valuation date the valuation date is the plane you're in and we'll talk about some some rare exceptions to that but the valuation date is that you plan your end so in many cases December 31st and then what you're going to want to pay a distribution as Susan Minister a totally feasible after the participant makes an election you don't want to trail over into the next plane year so for example you have to give a participant at least 30 days to make a decision and I'll get into this a little bit later more detail whether they want to rollover or a lump sum so you don't want to send out your distribution forms on December 15th if you're a calendar year plan because in that case they could take until January 15 to get back to you and now you've really got to wait for another valuation to be done and really reissue their statements and ever their distribution forms and everything with with the new amounts on them so you just want to make sure you don't cross over the next valuation and also the distribution form their elections are only good for 180 days after the distribution forms were sent that's usually not the problem you're going to run into but the forms once they're sent there's 180 days and then they're no longer good and that's a that's in look in the code so what do they get in in talking about what they get there are several things you can talk about we're going to start with what form of distribution do they get are they receiving stock or they receive in cash are they receiving some of each in some cases a participant has a right to demand stock and they can say I want to receive my distribution in stock and those are not those situations would not be true for an S corporation which of course many privately held Aesop's are and also for C corporation that restricts ownership substantially all outstanding stock to employees and the ISA participants and that would be pretty common for C corporation ISA to have that language in their articles or in their bylaws and so what we end up with is in most Aesop's now Bank ease ups are often different unless they're prohibited from purchasing their own stock as the next bullet point says but publicly traded bank ease ups are often the exception to that where yes a participant can demands talk the plain document must specify what the normal form of distribution is and that stock or cash or both so in other words if a participant doesn't elect stock specifically the normal form is cash they're going to get cash so and that's going to be in the plan dot document the end result in most eath ups most privately held Aesop's and most publicly traded but thinly traded Aesop's if the participants are going to end up with cash they may take a stock distribution and put it back to the company but they end up pretty much right away with cash either in their hand or rolling it over and that's that's how that's what we see in the vast majority of our clients now if it is a publicly traded ESOP and it's not simply traded there's no put option requirement so the person can actually hold that stock as long as they want just like they would hold any other publicly held stock and then sell it at a later time whenever they wanted to at the market price okay now what do they get we've talked about whether they what form they're receiving it in stock or cash are they getting a what we call a lump sum which is one payment within the payment of their complete eligible distribution in one tax year or are they getting several which is installments installments have to be paid at least annually they can be paid more than annually that I would say is pretty rare we tend to see annual installments if we see installments and they can't go over a period exceeding five years most people tend to think of that as five annual installments not necessarily true you can actually do six installments your first installment starts at time zero and then you you can have an installment you know at that anniversary date for each of the next five years you have to just be careful that that in last installment is within the five year period so even you can't even go over by a couple of days so you just have to be a little careful with that but you can actually do six annual installments over five years there is an exception to the five year period and that's for a very large account balances and I hope that you all run into this problem you can't extend installments these numbers are actually a year old and new numbers and I do apologize for this if an account balance exceeds 1 million and $15,000 this is just rather recently raised then you can increase their installment period by one year for each additional 200,000 so the 985 increased to 1 million in 15,000 and the 195 increase to 200,000 and so you can add a year for each 200,000 that you're over the 1 million and 15 more fraction thereof of that 200,000 however you can't exceed an additional 5 years so the most that you're paying out is installments over ten years no matter how large the account balance is ok now getting in to notice and consent requirements and these this all this information should be in your distribution forms that sometimes your TPA will prepare sometimes your attorney will prepare but but there's two components essentially to paying out a distribution one is notice that's the language that needs to be in your distribution form and consent is just what it sounds like a participant consenting to a distribution and there are some situations where they don't have to you can force them out essentially and we'll talk about those the rules for the qualified joint and survivor annuity provisions get super complex pretty quickly and they apply to almost no Aesop's and I'm willing to bet they apply to no one on the phone so we're talking about ease ups that do not have qualified joint survivor and do any provisions a lot of Aesop's used to have that years ago when they had money purchase a pension plan feature in their ESOP pede if you notice we do have a question oh yes yeah the question is can the installments vary depending on the evaluation of stock over the five-year period is that locked in based on the start of the account value at the time of the initial initial distribution great question it does vary not only can it vary but it but it has to vary with the the value changes over the five-year period that a participant has stock in their account so you're paying them out over five years essentially how you're going to do it is you're going to pay typically what you do is pay one-fifth of their stock one-fifth of their cash in year one and your two you pay one-fourth of their stock one-fourth of their cash revalued at the new valuation and then the third year one-third of their stock one-third of their cash once again revalued at the new valuation on down until you have a last payment where you're paying out the final installment so yes it does change the stock is never is never locked into a certain price when a person is receiving distribution they have stock in their account it is at that stock is paid at the most recent fair market value so it's never locked in there are ways of converting that stock to cash before a participant actually takes a distribution and that changes their investment from being an account that has stock in cash to being one that just has cash invested in some fiduciary responsible way but they no longer have stock so in that way you can kind of lock in the value but you're doing it by taking the stock out of their account do you have another question are the number of installments for the large balance accounts set at the start or can it change if the value hits the next break point that would be set at the time you start paying the distribution so right now if you started paying a distribution right now you you've you you've essentially entered into agreement that person to pay them a distribution in a certain form and that distribution is set at whatever years let's say they had let's let's say you started them when it was the threshold was nine hundred eighty five and they were just a little bit over nine hundred eighty five so you could add a year so there so you're paying them out over six years so you've essentially entered into an agreement with them signing their distribution form to pay them out over six years and so you would have to pay them out over six years you can't you can't go by the new numbers now if you it's not locked in when the person terminates it's locked in when you actually start paying the distribution and the end the statutory thresholds at that point in time and if any of my questions don't make sense just hit me with another chat there we'll take care of it okay notice and consent requirements so this is if a person has a vested balance over $5,000 I'd say five thousand here you can have your threshold set at one thousand it did that would be in your plan document you really have the option kind of between the two is what most would have chosen you would either five thousand or one thousand so this can apply to one thousand if that's the threshold in your document but the person must be given a notice distribution forms 30 to 180 days before the distribution begins that notice must describe the optional forms of benefit and the person's right to defer distribution because if they're over the involuntary threshold they do have a right to defer the distribution essentially until in most plan documents until retirement date they have right to defer that distribution must also include a special tax notice which now has a new name but it's essentially the same thing it's a IRS approved language which explains their rollover and lump sum options and the consequences of taking a payment either directly to themselves or of rolling it over that we in our documents in our distribution forms we do use the IRS approved language that can be modified if it is modified and if we were requested to modify it I would always make sure that that my clients attorney looks at it as well there are some things in that special tax notice that won't apply to your specific situation it's kind of one of those all-encompassing three or four page IRS documents so it can be changed it can be simplified somewhat but you just have to be careful so the distribution form itself is going to have to tell them okay you can take installment you can take a lump sum you can roll it over you can take it directly to yourself all the different options they have under your plan and then you also have this special tax notice and you have to tell them that they can delay the distribution so if they're over that your involuntary threshold whether it be 5000 or 1000 they must consent to distribution timing and there are a couple of exceptions to that and the biggest one is planned termination if a plan terminates and the employer does not maintain another defined contribution plan that is continuing on then you can force distributions out because there's really nowhere else to hold it and so we have seen several acquisitions of these knobs etc where the shop has been terminated and where this were or terminated for other reasons where this applied and I already talked about the timing we did I did say that you have to give them 30 days to before you start paying out the distribution from when you send the distribution form to when you start paying out the distribution they can and and our forms in most forms would actually say by signing this form I agreed to waive my 30 that 30-day period and I'm going to get the distribution as soon as administrator' feasible so if you send out a form someone returns it within a week they've signed it you could pay that distribution out right away you don't have to wait to 30 days in reality most ESOP companies will pay it will have a particular window where they send out distribution forms a window of time and they will have a they will wait for although that window to close then they will take all the forms and process all the distributions at one point in time I do see another question here during a greed distribution payment schedule if a retired employee has a hardship can that distribution distribution agreement be modified most isa the answer is yes it could be if that's in your plan document most ESOP documents do not include hardship provisions some do but it's pretty rare so essentially the what yes the law would allow that but most ESOP documents don't unlike 401k plan don't include any type of hardship so that would be a question where you you'd have to check the plan document and see what it allows in that particular case legally yes it could be done if it's in the plan document so if you have a vested account balance less than five thousand or less than one thousand if that's your threshold then typically tend the same distribution forms it technically full notice is not necessary you don't you have to tell them that they you of course you don't have to tell them that they can delay the distribution because they can't you do have to give them the special tax notice the way our forms are drafted every participant essentially gets the same form in most cases and there would just be a box that says this this provision does not apply to any but it was account balance less than five thousand dollars and then that provision would be a check box where they could say I don't want to receive my distribution at this time so if they have something less than five thousand dollars they can't check that it's not eligible for them but it's still on the form they still have they must have at least 30 days to elect rollover or love or direct payment to themselves and that is basically to give them time to talk to their financial advisor decide what they want to do you don't even need to provide a rollover option for distributions less than 200 in other words you don't have to go through the trouble of rolling it over you can just give the person a check and then the if somebody does not return a form they would just be paid out so if your threshold is $1,000 a person has $900 in their account balance that's vested they don't return their form you can just send them a check now if they have between a thousand and one dollars and five thousand you can still force them out if five thousand dollars is your threshold but it has to go to an IRA that's been set up in their name and there are many many many financial institutions who would certainly handle that for you in some cases it could be your 401k providing some cases it could be the bank that you work with you know as a company they'd be happy to set that those IRA accounts up for you and then the participant gets a notification from them saying hey your money's with us now if you ever want it come get it got a a question here is the 30 day notice necessary before paying out de minimis vested balances in lieu of RMDs the 30 day notice is always necessary if the account balances over $200 so if it's smaller than 200 it because if it's $200 or less they don't have a rollover option you can just send them they have a hundred bucks in your account you just send them a check anything over $200 yes they have to have the 30 days so by de minimis I'm thinking that would be less than $200 and so the answer is that the 30 day notice would not be necessary okay withholding requirements there's a 20% withholding on any distribution over $200 that is not rolled over if it's if it's under $200 200 or under again you don't have to worry about the 20% but if it is over 200 the person doesn't elect to roll over then there is a 20% withholding and it gets a little bit different with stock distributions I'm going to talk about that in a second but just in a regular cash distribution it's essentially just 20% of the value of the account that you're paying obviously if they roll it over the whole idea of doing the roll over is they're not touching the money at this point in time they are just putting it into another retirement vehicle another tax deferred vehicle so there is no with holding there's a 10% withholding on distributions not eligible for rollover and these in most cases for Aesop's would be required minimum distributions if the ESOP ball has a hardship provision that would also be the case for that because hardship distributions aren't eligible for rollover so anything not eligible for rollover falls under this 10% umbrella however the payee may elect out of that 10% and have no withholding or have more withholding taken out again I think I'm repeating myself on the next bullet point there's a 20% mandatory federal withholding if the amounts aren't rolled over except for an R and B essentially there may also be state withholdings that's determined not by where the many years but by the participants residents and it may either be mandatory depending on the state or it may be at the participants request so that may it may be voluntary that they can have something withheld for their state taxes I see a couple of questions here the first question are the options to close out an account of a participant with under 1,000 who cannot be found after several years of effort or are there options to close out an account of a participant with under $1,000 who cannot be found after several years of that effort yes there are if you can't find it it's it's you know what we're dealing with here is a lost participant and if you this should be in your plan document and typically what we would see is that you can you have to make a good-faith effort to try to find the participant typically that means you're going to use the either the IRS or the social security letter forwarding programs and through those programs you send a letter to the IRS you put it in an envelope for the individual you put it in an envelope to the IRS the IRS never actually looks at the letter they just forward it on to the most recent address they have for that person same with Social Security they send it to the most recent address and that letter is essentially going to say hey you have some money it could actually be the distribution forms it could be something say hey you have some money give us a call and we'll talk about how you can get it once you've done that if the participant does or if the individual doesn't respond the plan can have and many do have an option to forfeit that account balance and treat it just like a normal forfeiture and reallocated to other participants and the the plain document will also say if the person ever comes back and asked for their money they are going to get their money first funded out of that current year's forfeitures and then if necessary out of any employer contribution so yes there is there are options and then I do have a question is is the 10% on top of the 20% so I mentioned here the 10% withholding on distributions not eligible for rollover that is instead of the 20% not on top of it so for any distributions that can be rolled over that are not that withholding is 20% for any distributions that cannot be rolled over like an RMD the withholding is 10% period not in addition to 20% is 10% unless the participant elects to have either less or more than 10% without okay so here's just a kind of a straightforward example of cash withholding you just simply take the the distribution that the participant is eligible for they haven't decided to roll it over they're taking a direct distribution to themselves and you multiply that by 20% and they're withholding is is in this case two thousand two hundred forty-four dollars and seventy two cents so the participant is actually going to receive a check of 80 percent of that eleven thousand to twenty three sixty you're going to withhold that mm to 4472 and I'll talk about that in a little while about what you do with that state withholding is mandatory in about sixteen states and we say about sixteen states because it changes somewhat frequently I mean you have 50 states that you're dealing with and so they're they're different tax laws are changing and they're changing that particular option from time to time and then state withholding is required on upon a participants request in another 25 States of course there are many state there are several states without any income tax at all personal income tax so they have no withholding at all and even some of those that have a personal income tax state state personal income packs still have no with holding or do not even allow withholding on retirement distributions so you kind of have a mix so now we get to stock distribution stock distributions get a quite a bit more interesting with regard to everything with regard to taxation and one with regard to withholding now keep in mind a stock distribution in most cases in a privately held Aesop's still ends up with a participant holding cash in their hand in most cases they're simply signing another form that says I understand I received a stock distribution and I am immediately putting my stock back to the company and that's part of their distribution package so the they're not receiving cash from the east out there technically receiving stock from the East op and then the company is in the company not the east well the ESOP can but typically the company is immediately buying that stock back from them and they are ending up with cash in their hand to most participants it looks exactly like a cash distribution however there are reasons to do it - you know for the company to pay stock just for the east up to pay stock distributions as opposed to cash distributions one of those reasons would be if the company wants to get stock out of the ESOP maybe they're kind of winding down the ESOP or maybe the benefit level would be too large if they contribute cash in the ESOP to recycle shares that year so there are reasons the company may want to get stock out of the east up there that it also in many cases provides a great tax benefit for those receiving distributions which I'll talk about but talking specifically about the withholding the withholding on a stock distribution is 20% on the cost basis the cost basis is what the ESOP initially paid for the shares or the fair market value at the time the company contributed shares if it wasn't an esop purchase there was a stock contribution it'd be the fair market value at the time these up contributed the shares so let's say you had a leveraged ESOP and the company and the ESOP paid $10 a share and that's all the shares in the ESOP so you have a cost basis of $10 a share whether the shares get recycled or reallocate those forfeitures as long as they stay in the ESOP that cost basis remains the same at $10 a share so participants withholding is based on that cost basis which your TPA should be tracking even if you don't pay stock distributions it's easier to track the cost basis as you go in case you ever want to pay stock distributions cost basis can be rebuilt if it's not currently being tracked and you decide later you want to pay stock distributions it can be rebuilt but that tends to be more difficult than just tracking it as you go along with each ESOP transaction now I mentioned that the withholding is 20% on the cost basis however it's limited to the cash that was available in the participants account there's no need to ever use any of the shares the proceeds from the shares to fund withholding so if we look at a a distribution that is all stock the participant has no cash in their account you know you'd calculate the 20% of their cost basis but there's no cash so they actually have no withholding there's no withholding on their distribution there's also a 10% early withdrawal penalty if they're under fifty nine and a half that's not in addition to the ten percent withholding they pay that when they pay their taxes but it's in here because it's also based on the cost basis in a regular cash distribution that 10% early withdrawal penalties is based on the full amount that they receive in a stock distribution it's based on their cost basis then we have a piece called net unrealized appreciation and that's the fair market value at that time they take their distribution minus the cost basis so in other words how much have the shares appreciated since the ESOP purchased the shares and that is taxed as a long-term capital gain rate in the share of this when the participant sells the shares back to the company in most cases in most privately held Aesop's they're selling the shares back immediately so there especially as core piece ups they are selling the shares back immediately so their remainder of their there they're taxed all in one year cost basis is taxed at their personal income tax rates withholding is BAE done that anyway penalty is based on that that unrealized appreciation so the appreciation of love cost is taxed at the long-term capital gain rate which is 15 percent and that's regardless of how long the East I'll tell the shares are how long the participant is held the shares this net unrealized appreciation all of this treatment does not apply if the person rolls it over you know there's no tax implications at all when they roll it over they roll it over and they would ultimately be taxed when they take it out of their roll over at whatever the value is at that time the full value it's also not available on installment distributions it's available only if the person is taking a full distribution of their account balance in one tax here if the participant doesn't sell the shares right back to the company there's an additional tax on any appreciation above the price at the time they took the distribution and that would be taxed in in accordance with normal capital gains taxation long term if they held it hold the stock over a year short term if they hold it under a year for that piece above the fair market value at the time they took the distribution this is this is a I do apologize it's pretty complex talking about stock distribution and the tax effect but you can see where there might be a great tax advantage for an individual to pain that unrealized base 15% on the appreciation above cost basis so I do have a question can you explain how you calculate the cost basis for individual nua transactions the cost basis is typically you know it with almost all of our clients if whatever client we have if the cost basis is available when we take over that client from whoever did the work before if someone else did the work before if there is a cost basis we continue to track the cost basis so I have for 99 percent of my clients I have cost basis by participant at the participant level for the stock in their account so it's not so much effective calculation it is I have it for each individual I know that Joe Smith has a thousand shares and his cost basis is ten thousand dollars or whatever it might be so I know that as much as I know what the value of his account is so we're tracking it from year to year to year four though we just recently had a client who cost basis was never tracked before we took over doing the record-keeping they just this year decided to pay stock distribution so we are rebuilding the cost basis for them and and that's essentially done kind of on an average basis the ESOP purchased you know this many shares over the years and they paid this price for each transaction so what's the average of all those so it kind of gets an average cost basis for each participant but again we put that in each participants account we put their their calcaneal calculated cost basis in each participants account and then we'll carry that forward going onward so I hope that answers that question I will get into there some adjustment done to the cost basis for escorts and I do get into that a little bit later so this is just showing kind of a simple mathematical thing that maybe makes things a little bit clearer so this cost basis the ESOP acquired to share this person has 100 shares in their account these hop acquired those shares at $10 a share so the total cost basis is a thousand dollars it's gone up five bucks a share while the participant as as or you know since these I've acquired them and the fair market value is $1,500 the nua is the difference between the two the difference between the fair market value distribution in the cost basis so it's 500 bucks a share now the participant in this case not typical for an S corp ease up especially not typical really for most II styles are privately held but they're holding the stock they're not selling it right back and they can do that in some cases and so the the price goes up again looks like they made a good decision they held on to it it went up 7 bucks a share so the appreciation above and youäôre above that net unrealized appreciation is another $700 so the $500 the thousand dollars would be taxed with their ordinary income tax rate the $500 nua would be texting the long-term capital gains rate when they ultimately sell the shares and the 700 dollars would be taxed at the long-term or short-term capital gain rate depending on how long they held the shares after distribution they held it over a year it'd be taxed at 15% if they held it less than a year be held tax at the short-term cap gains rate okay and so here's just to talk about I talked about this already I won't spend too much time on it but they're withholding for that individual with a thousand dollar cost basis they calculated withholding is $200 plus whatever cash they have in their account so in this case we're assuming the person has four hundred dollars of cash in their account that they're also receiving as a distribution so they're calculated withholding in this case is two hundred eighty dollars you can see that they do have enough cash to withhold the two hundred eighty dollars they have four hundred dollars in cash so the holding in that case would be done to its full calculation there are cases where as I mentioned there's no cash at all so there's no withholding or there's not enough cash in the participants account to cover the full calculator withholding so you would just withhold as much cash as you have and it's important to note that all of this that we've talked about thus far is withholding the participant they're still going to pay taxes based on you know they based on the long-term capital gains rate if it's a stock distribution with net unrealized appreciation they're paying on their personal income tax rate on the cost basis all that they're still going to pay so withholding is just essentially a prepayment just like withholding on payroll it's the same idea it's just a prepayment of the texture ultimately going to pay so whether or not there is withholding there's not effect whether the person is going to be taxed or not it's just whether they're prepaying or not you withholding requirements there are it's not subject to mandatory withholding of course a rollover and that would be to any an IRA or to a any other qualified retirement plan any distribution paid is an annuity which attend to not you don't see in the ESOP world distributions paid over 10 years or more which you tend to not see but you could see if a person had a large it's actually over 10 years I'm sorry notes this we shouldn't paid over a 10-year period so yes if you had a person with a very large account balance and was stretched to the full 10 years there would not be withholding on those installment distributions distribution paid to participant reaching age six seven and a half we're talking about the required minimum distribution there there's not withholding on that except there is the 10% but they can waive that distributions less than 200 and then hardship distributions hardship distributions also 10% but they can waive that so there's no required withholding on that feat just an eye in the clock I've got a 45 minute mark and okay plenty of material left so okay I will move forward you're right I should I have to pick up the pace a little bit there positive tax withholdings I think everybody is familiar with this the it's now required that in most cases your withholdings be handled through the EFTPS electronic depositing there's if you have small with holdings of $2,500 or less during a tax period you don't have to of course once you have it set up if you have a year less than 2,500 you're still probably going to use the electronic depositing I give the website there if you're not already signed up for it but you probably are then that can help you get the information that you need to actually do the electronic depositing the IRS is insisting on it they will actually give you a failure to deposit penalty if you are required to use electronic and you do not use paper or some other well that would be the other type of it holding okay calculation of the tax there you know a regular distribution as I mentioned taxed up personal income tax rate when I say regular mean cash distribution stock distribution we talked about the taxation on that if a participant is under fifty nine and a half there is a ten percent excise tax on their distribution so it's their personal income tax rate plus ten percent so it's an additional tax and for cash distribution that would be on the full amount on a stock distribution would be on the cost basis there are some exceptions such as a participant who separates from service in other word terminates after age 55 disability quadros and we have them listed here there is no exception for hardship distributions or diversification there still is a 10% excise tax of the persons under 59 and a half we talked about is quite a bit already oh I did the one thing I wanted to touch here is the second bullet point as corporations have to if they are distributing stock they have to adjust their cost basis in the ESOP and it's essentially adjusted upwards for earnings per share downwards for distributions S Corp income distributions per share there's some other adjusting entries but the cost basis is adjusted on an annual basis and we do that for clients who pay stock distributions for those who don't if they ever decide to pay stock distributions that's information we can get and very easily catch up on and allocate the aggregate adjustment at one point in time passed through dividends probably doesn't apply to many see Corpse only only see crooks can pay past through dividends and that's essentially where a participant receives dividends either actually flowing through the ESOP or paid directly from the company but they receive a check for dividends based on the stock that they have in the ESOP it is taxed at the ordinary income tax rate it doesn't get the fifteen percent dividend taxation rate it there is no ten percent withholding all the stuff we talked about distributions notice in consent all that kind of stuff is not applicable distribution of pass-through dividends are treated separately there's been many attempts to make this also applicable for S corporations so that as corporations could pass through income distributions that none of those have been successful or even move very far in the legislature we'll talk about the 1099 are a little bit that 1099-r is the form that's used to report taxation to report the amounts that a person received so person receives at ninr they know what to put on their tax forms and here's a picture of it in all its beauty I'm going to use the pointer here for a second growth distribution is going to be the full value of their distributions so cash plus the fair market value of the stock taxable amount will be the if it's a rollover it's going to be C if it's not it's going to be if it's a cash distribution will be the full value if it's a stock distribution it's going to be the cost basis the other item you would see is net unrealized appreciation if it's a stock distribution the total of box six and box two a will equal box one so you'd have the cost basis and then the appreciation above the cost basis right here is the other item that really applies is the distribution code this is where you're telling the IRS if the person rolled it over if they didn't roll it over if there's an exception to the ten percent penalty etc and I have all the codes listed here by the way if anybody wants a copy of this specific presentation of course will be available I can also send it to you if you'd like so those are the those are the boxes these are the codes I touched on the ones that we tend to see of course you have death and disability normal distributions and no 10% penalty that's up somebody who's over fifty nine and a half there's also the nine forty five which just records your withholdings how much you withheld and when you submitted it and then there's a form 1096 that covers just summarizes all of the 1099 RS that that you're submitting special situations required minimum distribution card minimum distribution basically Congress said if you're over a certain age we're going to make you start taking these minimum distributions if you're over a certain agent terminated specifically or a 5% of the company we're going to start making you take these distributions the idea being we didn't mean retirement plans at some estate planning tool we meant for you to start taking this and using it for your retirement so the it's generally a small percentage of the of the participants full account balance but once a person attains 70 and a half and is terminated 14 70 and a half and is a 5% owner they need to start taking required minimum distributions in the first year if they're not a 5% owner if they're under the 70 half and terminated category they get a three month grace period essentially till April 1st of the following year to receive that distribution every year after that it has to be paid by December 31st so that's something that you know for our clients we certainly tell them who needs to receive an RMD you can also help them with the forms etc but that's something that you have to be careful to watch and make sure that everybody is 17 - terminated is receiving the required minimum distribution and these amounts can't be rolled over so if they're also eligible for distribution and the participant elects a rollover the RMD amount has to be carved out of that and actually sent in a check to them qualified domestic relations orders the big message here is if you have a Quadro or actually if you know of a pending domestic relations order and distributions are occurring they should be suspended if if you have a Quadro in hand you need to well I'll say this way if you have a domestic relations order in hand you need to look at that and make sure perhaps with your attorney make sure it has all the information for your plan to consider it a qualified domestic relations order and what it will tell is how much the alternate payee is going to receive based on what date evaluation are they going to get earrings after that day how they're going to be paid all that good stuff so it's going to specifically state how the payment to the alternate payee should be handled do you have a question if the employer expects a Quadro should the diversification distribution be held as well very good question I would say I've never encountered that but I would say probably yes because it's possible that I mean I think you would want to stop any money going out of the plan because you don't know what that Quadra is going to read now obviously if the Quadra says the person is going to get 50% of the account balance the participant taking 25% for diversification doesn't really impact that but in some cases the alternate payee receives all of the retirement balance and you don't know what that's going to be so I would say yes that you would want to suspend any money going out of these up to that individual there can be there often are transactions that take an esop from a certain percentage of ownership let's say 30 percent to a hundred percent or to just a higher amount seventy percent whatever we would call the second or third stage transactions whichever whatever the case may be the additional debt taken on in that transaction especially if you're going from thirty or forty or fifty to a hundred percent is pretty substantial and has a has an impact on the value of the company and so what will often happen is price protection will be put in place for the stock already in people's accounts at the time that occurs at the time that transaction occurs in other words you're not punishing participants who already have stock in their account from the first transaction because the second transaction is happening that's going to reduce the actual value of the company it's a it's pretty tricky on the transaction like this I would certainly really on any transaction where these helps according stock I'd recommend an independent trustee but certainly on something where price protection is going to happen oftentimes the price protection will only cover death death disability or retirement because other terminated people you knows but it will have an option to not take their distribution yet to let the stock price come back then there's there are some legal questions on how the value is calculated do they get just a floor price we're putting a fixed floor price in that these people we stock in their accounts will not receive anything under this floor price no matter how low the stock goes or do we do two valuations one that incorporates the debt into the value which is the true value of the company or what and one that treats it as if the debt isn't there which would be the value of the company without that so there's a lot of questions surrounding it but certainly something that should be talked through if there is a second transaction almost done here special situations if you have a situation where the the company has done either fabulously well since the last plan you're or fabulously bad since the last plane your end the it's really a trustee to fiduciary trustee decision as to whether you can really pay people out using that most recent fair market value that most recent fair market value may be very very far and I'm not talking subtleties it may be very very far from actually reflecting the value of the company at the time the person is taking the distribution and so that's something where if that is occurring you should consult with your attorney the trustee should consult the attorney to determine if an interim valuation is necessary plant terminations plant terminations often do change how distributions are paid if the company is being sold or merged distributions may be suspended permanently because really you're the independent appraisal done by your your valuation firm is really not I don't wanna say it's not valid but given the circumstances that the price is going to be changing because somebody's buying the company at some negotiated price probably above what the the year last fair market value distributions are often suspended until that is figured out also distributions may be delayed once the once the acquisition or transaction happens oftentimes you'll wait for the IRS is approval of the termination there's a filing that's done with the IRS one when a plane is terminated it doesn't have to be done but it's nice to get the IRS is blessing that everything was done correctly and then there also may be a case where people receive part of their distribution once you have IRS approval but where if there's an escrow account that's paid out over it could be you know three four or five years they will receive subsequent distributions after that we have actually a couple of those going on right now and I don't think I received any more questions here's all my contact information certainly certainly feel free to call or shoot me an email and we went through a lot of material in an hour so if you have any questions that you didn't get to ask or that I didn't answer as clearly as you would have liked don't hesitate to call or email Pete that was great absolutely fantastic yeah you're right well here's one that just came in you might want to get this one somebody asking for a copy of this slide okay you already said that we can do that for all of you that are on the on the session right now as we speak following the end of the session you'll be receiving a feedback form just mention on the feedback form that you would like a copy of the presentation or you can email me here at the OEO C that you would like a copy we'll get you a copy there are no other questions that popped up and I have one or two quick we recently had a webinar that covered repurchase obligation topic which also can be very very critical to an esop company and one of the points that was made in that session was that the plan document provisions have a great effect on the repurchase obligation calculation going forward and one of those provisions that has a great deal of effect is the distribution policy can you just say a word about distribution policy and repurchase obligations yeah absolutely how you're paying out distribution whether it's hard-coded into the plan document or whether you're playing documents flexible and it's hard-coded into your distribution policy has a massive effect on on on the repurchase obligation I mean you can imagine if you are let's say you have an older demographic and you pay lump sum distributions and your company's been doing fabulously well you have a lot of people with very large account balances and they've been with company a long time the stock price has risen etc and you payout lump sum distributions no matter what their amount is you can see how that has a much bigger impact on cash flow then if you spread those out over installments so there is a there is a big impact on how you choose to pay distributions and in the repurchase obligation repurchase obligation is what the company has to come up with the fund distributions and the generally the more flexibility that you give the company as far as cash flow the better off you are for for example something like installments something like making terminated participants wait some period of time you know there's there's you know that's kind of a two-edged sword because if you pay installments you know four-fifths of the person's account balance is still rising if your stock price is rising but something like that definitely eases up on cash flow and spreads out the obligation actually there's a good example of a company that you know had tremendous cash problems ultimately went bankrupt for this and other reasons they paid a media lump-sum distributions and did fabulously well leader in their industry did very very well and you know they're the first time their stock price took a tick down there was somewhat of a run on the bank I mean we're talking very high six and seven-figure account balances and many people in that you know fifty five to sixty thinking about retirement anyway and there was a run on the bank and and that's just something that's you know very difficult for a company to handle so you have to have provisions that make sense you don't want to make participants wait forever to get a distribution but you also have to make sure that the company can handle the distributions as far as the company's cash flow goes great answer yeah that's kind of what I was looking at that 100% immediate lump sum distribution on separation would be would be one of those absolutely yeah you would look at as an administrator taking on a new client you'd want to look at their plan very carefully and there are probably that and maybe other common traps if you will that that would catch your attention you'd say oh this could be a problem going forward yeah we do we look at that and we talk about it and some of our clients have said yes we pay hardly anybody pays immediate upon termination but they may pay full lump sum with no upper threshold you worked installment to kick in you know the year after termination you're after retirement and so we would mention that hey you know you've got some pretty sizeable account balances here you may want to think about installments over whatever number makes sense for you maybe it's a hundred thousand maybe it's fifty thousand and some say yeah we've looked at it we're happy with it in a couple of years we'll have you do a repurchase study to make sure we're still happy with it and some hadn't really thought about it and you know we helped them with that but definitely something to to certainly look into to see you know worst case scenario what's going to happen especially if you have an older population that's eligible for diversification they're eligible they're approaching retirement age they have those large account balances it's definitely something that should be run through some sort of repurchase obligation study whether you do it yourself or have do it to see and then and then that can be plugged in you know by by the CFO typically into the cash flow modeling and see how how that affects the company great bead I think we're about out of time and I want to thank you for staying over for a few minutes we had no problem at all yeah great questions great great topic and I might say great presenter I think all of you are there listening or convinced that Pete really knows his stuff so again I want to thank you all for attending don't hesitate to contact Pete or me at the OEO see for further information on this topic and again we're going to archive this session for future viewing so please see our website for access to that webinar what also reminds you of some future events put on by the OEO see we are almost complete with the the spring webinar series this is the fourth of five webinars and on April 10th we will be talking about valuation and Scott Miller of Enterprise Services will be presenting and for those of you who haven't heard Scott I think you'll enjoy Scott's presentation that we're going to try to demystify the whole subject of valuation valuation obviously is critical to your company and all of your employee owners and often that's a very confusing topic that we want to straighten up also most of you know that our 26th annual Ohio employee ownership conference is coming up in Fairlawn on the 20th of this month so visit our website for information to register for that and also don't forget that the day before that conference on the 19th in the same location at the Hilton in Fair Lawn we have a pre-conference day with CEO forum CFO forum and an HR communications forum with a networking dinner to follow so get information from our website on that as well again you will receive an email feedback form following this and please give us some input so we can improve our presentations and provide future subjects that you want to hear about so at this time we'll end the webinar and I want to thank you very much excellent thanks Jay thank you please stand by